Professor Per V. Jenster of CEIBS has led a team of senior experts in a recent research project for the EU Commission, entitled: "Future Opportunities and Challenges in EU-China Trade and Investment Relations 2006-2010," presented on February 27, 2007 by Trade Commissioner Peter Mandelson. The team carried out in-depth studies across eleven of China's most competitive sectors, surveying over 200 foreign companies in China. The sectors covered in the research included Machinery, Chemicals, Automotive, Pharmaceutical, ICT Equipment, Agriculture, Financial Services, Distribution and Retail, Construction, Telecommunication Services, and the Sustainable Technologies and Services Sector. A twelfth theme explored China's intellectual property environment across all sectors.
According to the research, China's rise presents a great challenge to the global economic system. As globalisation progresses, European operators are beginning to compete head on with Chinese industry, and the question of Europe's competitiveness in an open world economy is becoming an increasingly important one.
Formulating a response to China is in many senses similar to formulating a response to globalisation itself. Low-wage workforces driven by labour surpluses, which form the main thrust of China's competitive advantage, are common to many developing countries, though not all have been able to climb the technology ladder and boost productivity as quickly. Europe, along with other developed economies where ideas and the production of knowledge drive economic growth, must therefore carefully consider its role in the global economy and focus on what it does best.
Competitive Strengths
The report emphasizes that in terms of competitiveness in labour-intensive manufacturing, Chinese industry is second to none. However, European operators still enjoy a sizeable advantage in higher value-added economic activities such as:
- Innovation and R&D
- Design
- Marketing and branding
- Servicing (after-sales, customised solutions)
- Management
- Overall superior quality of goods and services
- Financial strength (applies mainly to multinationals)
The range of competitive strengths of European operators is therefore relatively comprehensive and covers nearly all aspects of the spectrum of competitive factors except for price, with the exception of some large retailers who are able to leverage buyer power. Therefore, at this stage, it is useful to make a number of distinctions.
The first distinction is to be made between manufacturing and services, while the second distinction is between commoditised markets and specialised high value-added markets. Clearly, European operators are at a competitive disadvantage in commoditised markets, in which price plays the most important role. It is in these markets where European operators are faced with the greatest pressures and only those which successfully relocate production to or source supplies from low-wage countries are able to compete effectively.
Those European manufactured goods which contain high value-added in the form of R&D or design are largely able to retain their market share in European markets by differentiating their products from Chinese goods. This applies equally to export markets. As incomes in China grow, demand for higher value-added products will also increase presenting significant opportunities for European operators. Moreover, as environmental standards are raised in China, European operators offer the world's leading environmental products as well as the technologies for cleaner production, energy etc. However, this is not to say that all is well for European Companies. Chinese manufacturers are climbing the value chain and starting to internationalize. A general increase in the quality of goods and services (e.g. machinery, automotive, ICT, chemicals) combined with low-cost bases allows for entry into markets which were once the domain of European companies, particularly rapidly emerging markets such as ASEAN and globally in South America, the Middle East and Africa.
As for services, the advantages enjoyed by European operators are considerable. For the 5-year period covered by this study, there exists little question of a competitive threat from Chinese service providers. While there have been some concerns in the construction sector about third market competition, little evidence exists that this threat is currently or likely to be substantial. However, investment barriers in service sectors in China remain problematic.
In all sectors the opportunities to maintain Europe's competitiveness will be realised by reacting swiftly to new paradigms and globalisation trends. It will be equally important to improve competitiveness at home.
* Cost competitiveness: Just as the lower costs of goods from China benefit European consumers, these trends bring challenges to European operators to reduce their own costs in order to maintain competitiveness.
* New concepts for home markets: Growth trends in the Chinese market can also lead to new innovations that can inspire European operators to develop new concepts and business practices which can then be adapted and applied in Europe.
Highlights of Sector-Specific Opportunities for Europe
In the machinery sector, the drive for lower energy intensity will lead to an increased demand for more energy efficient machines, power generators and renewable energy-related equipment, a field in which the European machinery industry excels. European operators must continue to capitalise on their superior knowledge of producing specialised, innovative, highly integrated and precise machines. Projections to 2010 put sales growth for European companies at 10% per annum, making China the market with the highest growth potential in the Asia-Pacific region for customised services. While China still has a trade deficit in machinery, import substitution strategies should result in a trade balance by 2008-2010.
In the chemicals sector, 2004 saw China's chemical imports (including pharmaceuticals) valued at around £¿44 billion (bn) and the size of the domestic market reach around US$ 180 bn. If further reforms (e.g. improved IP protection and the company law regime) continue to support market growth trends in key customer industries (manufacturing, construction and farming) the chemicals industry will grow at a rate of 10.2% CAGR. European commodity chemicals producers in upstream segments should leverage their financial strengths and invest in China, while speciality and fine chemicals producers should seek further export opportunities in China. Chemical companies should continue to capitalise on the strength of their customer relationship management expertise to provide customer specific R&D and servicing. Overall, European operators should build on their position as the world leaders in terms of energy efficiency, environmental management and the development of environmentally-friendly materials.
The automotive sector in China will see moderate to strong growth with overcapacity and increased local competition. Auto production capacity in 2010 is expected to be more than double domestic demand, increasing from approximately 8 million units a year to 16 million vehicles by 2011. The rapid introduction of new models in the Chinese domestic market will ensure that car parts will be an important export sub-sector for European companies. Furthermore, increased competition in the passenger vehicle sector in China could accelerate developments in low-cost, city-use vehicles which can also be marketed in Europe. Eventual crackdown on rapidly-deteriorating air quality in China will result in higher emissions and fuel quality standards, which will provide distinct advantages for European automakers since the standards are modelled on those in Europe.
In the pharmaceuticals sector, continued economic growth and rising living standards will result in the emergence of "diseases of affluence" in Chinese society. Longevity and the ageing population will fuel demand for drug categories that have preventative qualities e.g. OTC pharmaceuticals and "nutraceuticals", resulting in expected sectoral growth at approximately 10% per annum over the next five years. Other important trends include the growing use of self-medication facilities. Companies should explore innovative distribution channels in China, building on trends such as the emergence of pharmacies within retail chains in Europe, particularly as European retailers are rapidly developing their networks. An overall positive outlook relies on continued macro reform and an improvement in IP which will weaken the dominance of Chinese generics over foreign drugs. A strong rural strategy is required so that disparities in healthcare expenditure between more affluent coastal regions and rural areas are reduced. European operators may introduce Traditional Chinese Medicines within their product ranges in Europe allowing new growth opportunities. Considerable opportunities exist for European companies to leverage cost advantages from R&D in China.
In the ICT equipment sector, European operators should compete on design rather than in the manufacture of commodities. Future export opportunities should be targeted at those industries where the EU has established competitive advantage e.g. precision machinery, energy efficiency and pollution reduction technologies for the chemicals, automotive and agriculture sectors. This will help to ensure that European companies maintain their current levels of market share for which projections of US$ 130.5 bn in terms of revenue have been made for 2010. An overall positive outlook will require China to move towards adopting international standards to further market access.
Currently, agricultural exports rank 6th in importance in terms of EU goods exported to China. However, EU exports to China have been unable to reach full potential due to market obstacles such as China's SPS regime, insufficient logistics for transport to and from China as well as storage in China, and insufficient protection of intellectual property rights for some high-value agricultural products registered under well-known trademarks. Export opportunities exist in the agricultural services sector as the EU has substantial experience in organic production, value-added food production and sustainable land management. European operators also have considerable investment opportunities in China's rural economy such as in irrigation systems, supply chain management services, eco-tourism and biodiversity protection.
In the financial services sector there exists significant opportunities despite ongoing market access restrictions. Strong growth in the Chinese economy requires further reform and opening of the banking sector to meet the predictions of sustained 20% annual growth of consumer loan business, 50% in credit card business and 15% in business transactions. Due to limited market access, current market share of European banks is only 0.8%, though this is expected to grow to 3.5% by 2010. In insurance, the transition from state pensions and social support to private insurance provides foreign institutions with a chance to increase market share from 2% to 10% in the coming decade. European insurance houses' non-life and life insurance market shares are expected to grow from 0.4% to 5% and 0.8% to 8% respectively by 2010. European banks and other financial institutions should support Chinese banking reform, and bring innovation such as public-private partnership investments and excellence in customer servicing.
The opportunities presented by China are perhaps the biggest for European retailers. Foreign retailers are sourcing an increasing amount of products from China for their home markets (US$ 60 bn in 2005) and are leading the foreign expansion into the Chinese retail market, where total sales are predicted to grow at an average rate of 10.1% until 2010. Competitiveness in retail, gained by focusing on lean operations, supply chain management, integrated procurement, effective quality controls and management flexibility, and the ability to identify with local consumer preferences places European operators in a strong position. Chinese consumers are increasingly willing to pay higher prices in return for confidence in product quality and food safety. Sales of consumer goods (retail and wholesale) driven by strong growth in disposable incomes, urbanisation and population growth are estimated at £¿618 billion by the end of 2006 with 4% of sales by foreign retailers. This could grow to between 8% and 10% by 2010, though the dominance of European retailers will somewhat diminish as US retailers catch up.
The construction sector's share of national GDP rose from 6.7% in 1998 to 7.0% in 2003. This increase together with an average annual growth rate of 8.3% between 2000 and 2005, and an estimated annual growth rate of 7.5% during the implementation period of the 11th Five-Year Programme (2006-2010), indicates the significance of this sector in China. This indicates that China will be the world's largest building and construction market for the foreseeable future. While Chinese companies are in general low-cost and relatively efficient many lack the key expertise and management skills to handle large and sophisticated projects. The European construction industry is well positioned to take advantage of these capability short-falls and has global experience in adopting cutting-edge technologies in large infrastructure projects, as well as new concepts in sustainable building systems. However, beyond limited high-profile show-case projects, European construction companies are being excluded from the larger market, in particular the housing market. They have difficulty therefore in demonstrating their ability to offer integrated services throughout the entire life-cycle of a project.
China's telecommunications value-added services market remains all but closed. There is little prospect of foreign companies increasing their current minimal market share by 2010 unless China revises the current legislation governing the Telecommunications sector, and lifts the equity ceilings on foreign investments (for example by allowing them to provide backhaul and to market services to corporate customers). As a means to circumvent restrictions in the telecoms and other hi-tech sectors, European operators should seek partnerships with those influential Chinese operators seeking strategic alliances in China (and internationally) for the integration of services in advanced service applications, high quality of customer relations, and management and marketing skills.
Macro Trends Create Opportunities for European Operators
* Environmental requirements for product features will be increasingly important in China. Through its 11th Five-Year Programme (11th FYP), China has set itself the target of achieving more balanced and sustainable growth where increasing energy efficiency, investing in renewable energy and overall environmental protection plays an increasingly important role. This has considerable implications for Europe's materials, engineering, construction, machinery, chemicals, automotive and ICT sectors. Service sectors can also take advantage of their product offerings to support environmental applications.
* Changes in consumption patterns: As China's middle class continues to grow in number there are increasing market opportunities for all consumer-orientated businesses and secondary positive effects for business-to-business operators. Rapid urbanisation and an ageing demographic structure will further influence the business strategies of European operators in the Chinese market.
